Basel III, Economic Certainty Nil

By

Patience Wheatcroft

Updated July 29, 2010 12:01 a.m. ET

Bank shares bounced earlier this week when details of the latest Basel rules on capital and liquidity were revealed. Investors were relieved that they were less stringent than had been feared. But had they looked at the reasons why the central bank governors had loosened their approach, they might have been less exhilarated.

Fear was the motivation that toned down the terms of Basel III; fear that many of the world's economies are still extremely fragile and that unless the central bankers trod extremely carefully, they could kick those economies back into recession.

ENLARGE

BOE Governor Mervyn King
Bloomberg News

One of those central bankers, the U.K.'s governor, Mervyn King, chose his words carefully to avoid scare-mongering when he addressed the Treasury Committee Wednesday but his message was clear. The gathering in Basel, he said, had been conscious of the importance of setting a long timetable for the changes it planned "because bank balance sheets are still recovering from the current crisis." He explained that "continuing concerns about the ability of some countries to achieve necessary fiscal consolidation are affecting confidence in the ability of banks to repair their balance sheets."

Then, just in case there was anyone on the committee still minded to be optimistic, he had this grim warning: "The key underlying causes of the crisis— in terms of the imbalances in global demand—have still not been tackled. Those imbalances are likely to be larger this year than last, and will probably still be around three-quarters of their level at the peak immediately prior to the crisis."

Beyond exhorting the Chinese to drastically revalue their currency and then spend it on Western goods, there seems a shortage of ideas on how those imbalances are to be addressed. Until they are, however, Mr. King believes that uncertainty over the world economy will remain.

Jim Rogers,
the veteran investor, does not do uncertainty. In an interview on CNBC this week he was adamant that there would be another recession in 2012. The phrase "double-dip" would not cross a central banker's lips but it was the spectre that clearly loomed over the Basel deliberations.

It could also be sensed lurking around a data produced by the European Central Bank. This shows that lending to businesses slowing down and lending criteria tightening in the second quarter of the year. The key factors in leading the banks to tighten their credit policy, explains the ECB, are constraints on the banks' own access to funding and their own liquidity management.

Mr. King echoed the problem. "The gradual improvement in credit conditions that was evident earlier in the year seems to have come to a halt in recent months," he said.

Against this background, to race to ratchet up the capital and liquidity requirements on banks would be foolhardy. So the restraint at Basel is to be welcomed but not seen as a signal of good times ahead.

Bright Ideas Please

To compete against the thriving economies of the east, the west needs innovation. The European Union this month announced a €6.4 billion investment in research and innovation in 2011 with some pretty ambitious targets.

According to
Marie Geoghegan-Quinn,
the EU's Commissioner for Innovation and Science, the money is for "cutting edge projects focusing on big economic and societal changes: climate change, energy and food security, health and an ageing population." She expects the package to create more than 165,000 jobs.

The planned investment has risen significantly above the 2010 figure. Some of the schemes that won backing from that money may well go on to create hundreds of jobs. Microscopic chemical robots, delivering ingredients around the human body may one day be seen as invaluable, although the Czech scientist being backed to develop them admits that it is "very challenging." Projects to develop cleaner fuels have obvious potential commercial application and various ideas for fighting cancer in its various forms have also won backing.

Some of the recipients of the grant money have, however, ventured into more unusual territory. For instance one project which plans to have a car arrive in Shanghai on October 10 this year, having travelled 13,000 kilometers from Italy. The novelty about this is that it will be a driverless car.

According to the Italian behind the idea, it will show that "intelligent cars" equipped with a sophisticated system of sensors, can travel through different environments and reach their destination, powered, of course, by green energy. If it works, the implications for travel and distribution could be huge. In the meantime, those using road this autumn between Italy and China may wish to keep a particularly careful look out of their rear-view mirror.

It is harder to imagine why the EU may have decided to back a project submitted by a German from a university in Bonn. He explains that he is investigating "What is the role played by our brain in the 'money illusion' phenomenon?"

His thesis is that people view a rise in their income as a good thing, even when it is completely wiped out by inflation. By investigating the thought processes that underlie economic decisions, he hopes to work out why the brain represents money as "nominal" and not "real."

The scientist sums up his aims in these terms: "The results may help explain why nominal wages rarely sink, whereas true wages, in contrast, fall in value in period of inflation."

But in a later sentence, he appears to answer his own question. "People like to be seduced by large numbers," he says. And EU commissioners are as susceptible as any others to that failing, particularly when talking about job creation targets.

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